One of the things we do most in daily life is to make decisions. Just imagine how much decisions we make in a day, and probably it’s the second thing that we do most frequently after breathing. Some of the decisions we make are very important and decisive for us, while others are less important. In other words, the returns of our decisions are quite different from each other and each of them has their own marginal utility function. So we need to be more attentive, rational and devoted in our decisions. At first we need to evaluate accurately, how important and what is the possible outcomes giving the right and the wrong decision. This topic was diffusively explained by Daniel Kahneman and Amos Tversky in “Prospect Theory: An Analysis of Decision under Risk” in 1979. In 2002 Daniel Kahneman shared the Nobel Prize in Economics with this theory but unfortunately Amos Tversky had died by that time. In 2011 “Thinking Fast and Slow” was published by Kahneman, that combines Prospect Theory with his following studies on thinking and decision-making. Let’s examine Kahneman and Tversky’s theory thoroughly and try to understand how bias and other cognitive and environmental variables effects our decision-making process.
There is a compelling drama going on in our minds, a filmlike plot between two main characters with twists, dramas and tensions. These two characters are System 1 (impulsive, automatic, intuitive) and System 2 (thoughtful, deliberate, calculating). As they play off against each other, their interactions determine how we think, make judgements and decisions, and act. System 1 is the part of our brain that operates intuitively and suddenly often without our conscious control. You can experience this system at work when you hear a very loud and unexpected sound. What you do? You probably immediately and automatically shift your attention toward the sound. That’s System 1. There are inherent survival advantages in being able to make such rapid actions and judgments. System 2 is responsible for our individual decision making, reasoning and beliefs. For example, imagine you’re looking for a woman in a crowd. Your mind deliberately focuses on the task: it recalls characteristics of the person and anything that would help locate her. This focus helps eliminate potential distractions, and you barely notice other people in the crowd. If you maintain this focused attention, you might spot her within a matter of minutes, whereas if you’re distracted and lose focus, you’ll have trouble finding her. The relationship between these two systems determines how we behave and how we decide.
More about System 1 and System 2
Imagine you’re one of the first human beings, and you’re walking with your kid and you see a lion. You don’t know what a lion is, so you take your kid over to play with him. And the lion eats your kid. So you go home and you’re sad, but it’s okay, you get your wife pregnant, and in five years you’re walking again with your new kid and you see a lion far away. This time you hide with your kid, and the lion eventually leaves and you both survive. So you come out, you start walking with your kid again and a bird flies over and all of a sudden your kid drops dead. And you go home sad again, you get your wife pregnant again, and you make a promise to yourself. You’re going to make sure that you hide your new kid from lions, and that you’ll hide him if you see a bird flying over. So there are two ways that we think. Both of the decisions that you made are based on the fast, automatic thought process, which Kahneman calls System 1. System 1 is where we find how irrational and illogical or just simply how stupid we really are. So it can lead us to not value System 1 or think that it’s useless. If you had used your slow, more rational and logical thinking , you would have found that you were right about the lion but the bird had nothing to do with your kid’s death. But we should value System 1 because it has a huge benefits. It’s the reason why we survived. Yes maybe at the cost of some really ridiculous assumptions, like your kid dying every time a bird flies over, but if we had rationally thought about what a loud noise might mean and analyze it carefully instead of being scared and running away from it immidiately, we wouldn’t be here. So understanding System 1 and System 2 is really important and there are huge benefits to both systems. The problem however really arises when we use System 1 instead of System 2, when System 2 would be the appropirate system to use. And this leads us to all kinds of biases and fallacies that are not optimal. It’s not optimal to think that if a bird flies over, your kid will drop dead.
If I were to ask you these two questions, what would your answer be? So one group was asked these questions, and another group was asked the exact same except instead of 1,200 ft in the first question, this time they were asked whether the height of the tree was more or less than only 180 ft.
Group 1. Is the height of the tallest redwood more or less than 1,200 ft ? What is your best guess about the height of the tallest redwood?
Group 2. Is the height of the tallest redwood more or less than 180 ft ? What is your best guess about the height of the tallest redwood?
So what do you think the answer looked like? The first group’s mean guess was 844 ft. The second group’s mean guess was only 282 ft. That is a huge difference. This is what is known as anchoring.
The Science of Availability
When I visit somewhere I’m not worried about a terrorist attack, and when I fly there I’m not worried about the plane crashing. And that peace of mind largely comes from the fact that I’m not really big consumer of mainstream media. But I meet people all the time who are really constantly worried. “Have you seen how terrorism is taking over the world? What are we headed towards? Have you seen how planes are just crashing all the time now?” But in reality, it’s not like the chances of those two things have risen in some dramatic proportion. They’re highly unlikely, and I mean a probablity very close to zero that your plane will crash. Even an event that has an almost non-existent probability of happening to you can be assigned a reasonable or even a high probability by you just because of what’s available to you. So again ask yourself, how can you use this concept to make your life beter? Is it beter to enjoy your life and realize that the world is actually not as bad as commonly portrayed, or watch the news every day where you’ll be shown constant death and destruction because that’s what sells?
Assume that I offer you to play a game with me. We’re going to flip a coin, and if you win, you win a $1,000. And if you lose, you lose a $1,000. Do you want to play that game? If you’re like most people, that is a game that you do not want to play. What if we change the rules a little bit. If you win, you win $1,100. And if you lose, you lose only a $1,000. From an expected value point of view, that is a good gamet o play. But if I asked you to play that game right now, and you knew that there was a 50% chance of losing your $1,000, if you’re like most people you stil wouldn’t play even though there’s also a 50% chance of winning $1,100. This is called “loss aversion”, and most people are very loss averse. In fact, you have to offer somewhere about $2,000 to get people to play. Again ask yourself, how can you use understanding this in your life? You know you’re going to be more convincing explaining to someone what they are risking losing, instead of what they could possibly gain.
Now imagine your doctor has to do an operation on you and she tell you, “There is a 10% chance that you’re going to die. “ She could also tell you, “There is a 90% chance that you’re going tol ive.” From a statistical point of view, there is absolutely no difference in those two statements. But in the first case you’re going to feel much worse than in the second. This is known as “framing”. How do you frame the exact same situation can have dramatically different consequences. Again ask yourself, how can you use this? How can you use framing to make good things more appealing and convincing to your friends or your children or whoever else want to influence?
I guess you are more clear about how our brain effects from communal and peripheral biases. So understanding System 1 and System 2 accurately, and being able to see possible outcomes of making the right decision and being able to define the marginal utility function of our choices might effect out entire life.